Chaos on the trading floor: Economists and speculators would like to be able to predict the ups and downs of the financial and commodities markets. Could chaos theory help?

By ROBERT SAVIT

IT IS a remarkable experience to visit the trading floor of a financial or commodities exchange. During an active period of trading, pandemonium reigns. Imagine the scene&colon; hundreds of people waving their arms and shouting at the tops of their lungs trying to make the right transaction at exactly the right time, while trying to monitor the behaviour of their fellow traders and assimilate the new information assaulting them from every direction.

But underpinning this melee, there are some specific rules and motivations common to all the players. The primary goal is, of course, to make money, and to do it in the least risky way. Is there any rational description of this capitalist brawl, and of the capitalist economies in general, of which these markets are a reflection and a seminal part? One important feature that all financial markets, and the larger economies share, is that they are systems with many feedback and self-regulatory mechanisms. We know, for example, that if the price of an item rises too high, demand for the item will decrease and the price will drop. This is the simplest of many such self-regulatory mechanisms in economics and finance. But the existence of these kinds of inherent mechanisms has profound and surprising implications for the ways in which markets, prices and economies could behave.

To see why this is so, consider a simple model of a system with self-regulating feedback. Suppose we have an extremely simple market with just one commodity, say, gold, for sale. The price of an ounce of gold during a particular week t is p(t). Suppose also that …

To continue reading this premium article, subscribe for unlimited access.